UK equities are the pariah of the investment world at present, with most multi-asset managers being increasingly underweight.
Near the end of 2017 they looked set to be the worst-selling sector of the year, making them the least popular destination for seven of the last eight years, Investment Association data shows.
“Being a contrarian at heart, my natural instinct is to take the opposing position and adopt a tactical overweight in the asset class,” says Thomas Wells, a multi-asset fund manager at Aviva Investors.
“However, in this case, I think it’s necessary to follow the herd and remain underweight. There’s simply too much uncertainty over how Brexit negotiations will develop for tactical risk-taking. Investors looking to take tactical positions should turn to other stockmarkets, in Europe, Japan and emerging markets, on the strength of their more attractive valuations”, he says.
Aberdeen Standard Investments adopts a similar view. Its multi-asset portfolios reflect a neutral stance on the UK, with more positive outlooks on emerging economies (reflecting better growth prospects) and US equities (supported by expectations of sizeable tax cuts), followed by European and Japanese stockmarkets (where currency movements pose greater concern).
However, none of this is to say that there is not a role for UK equities at a strategic level within a well-diversified portfolio. “Quite the contrary, but this exposure should be on a selective basis,” says Wells.
Although many financial advisers have been reducing ‘home’ bias in favour of taking a more global approach in recent years, UK equities remain at the heart of many clients’ portfolios.
Ian Head, owner of Berkshire-based Fund Management, has lowered his allocation to UK equities for a typical balanced investor from 45% to 32% over the past three years, but says: “Strong dividends and lack of worries over currency fluctuations will make the UK equity market an attractive home for clients’ capital in 2018.”
Last year saw the first synchronised growth in corporate earnings across all major developed markets since 2010, and equity markets responded, reaching all-time highs.
The UK, however, was the worst-performing major European market, with the FTSE 100 (UKX) index eking out a mere 3% rise by December – a far cry from 2016’s 17% gain.
With aggregate valuations less attractive than they once were, driven higher by one of the longest bull markets in history, professional investors are pencilling in only modest returns for 2018 – European Wealth expects a 5% gain for the blue chip index, while Shore Financial Planning, a Plymouth-based independent financial adviser, anticipates a flat market overall.
For many, the spectre of Brexit looms large. “Greater certainty over the direction of negotiations between the UK and European Union would be welcomed,” says Alex Wright, manager of the Fidelity Special Situations and Fidelity Special Values funds.
“Such clarity would provide a real-world boost to the domestic economy, as it would enable firms to have more confidence when it comes to making operational decisions around investment and hiring. But this is probably wishful thinking and I expect markets are probably going to have to contend with a more uncertain and volatile backdrop, even compared to 2017.”
Aberdeen Standard believes political uncertainty, together with a squeeze on consumer incomes amid rising inflation and weaker levels of wage growth, will make the UK lag most other global equity markets during 2018.
“Interest rate decisions in the UK are unlikely to have much of an impact on UK stocks, but if the US Fed is more aggressive in response to higher inflation then UK assets will take fright too,” adds Andrew Milligan, its head of global strategy.
Others, however, are turning more optimistic on the UK stockmarket. Seven Investment Management has moved some of its European equity exposure into UK shares.
“The FTSE 100 is the only equity market that has fallen since September with no real shift in earnings outlook, making it relatively more attractive to start closing our underweight positioning from a fundamental point of view,” says investment manager Ben Kumar.
“Increasing our UK equity exposure also means that in the event of a broad market correction, the FTSE 100 should outperform European equity due to the large, global and defensive nature of its constituent companies.”
Wealth manager Charley Stanley notes that more than 50% of FTSE 100 revenues are derived from abroad and, reflecting this, highlights a Thomson Reuters I/B/E/S estimate that FTSE 100 earnings will have grown by 29% in 2017.
Charles Stanley prefers to play the UK through overseas earnings, but points to the differential between the earnings yield on the FTSE 100 and 10-year UK government bonds being at its highest in almost five years.
“This measure of the so-called “equity risk premia” looks pretty generous and highlights that the equity market should continue to find support from low domestic bond yields,” says John Cunliffe, Charles Stanley’s chief investment officer.
Periods of macro-driven volatility tend to throw up valuation opportunities that are more difficult to source when markets steadily trend upwards, as has been the case over the last few years. In the decade since the financial crisis, steady businesses with stable cash flows – so-called ‘quality’ stocks – have been in vogue, driving strong growth in the share prices of consumer staples, businesses like Unilever (ULVR), Reckitt Benckiser (RB.) and Diageo (DGE).
“These types of company have historically struggled in an environment of rising interest rates and we could now be at a point of change where the market may start to reassess the prospects of hitherto unloved sectors,” says Wright.
Financials are his largest absolute sector weighting, with key positions in Lloyds Banking Group (LLOY), Citi group (C), and Bank of Ireland (BKIR). These, he says, have the potential to deliver expectation beating results in 2018.
Shore Financial Planning director Ben Yearsley has also been buying this ‘bargain basement’ end of the market: “I’m a big fan of financials. You could simply buy some of the stocks; Lloyds and Aviva look good value.”
Premier Asset Management and Liontrust Asset Management also believe ‘value’ stocks, which tend to have more cyclical earnings profiles and offer more immediate payoffs from periods of economic growth, will return to favour.
Premier sees attractive valuations in the life assurance and construction sectors, while Liontrust likes domestic housebuilders, resource companies and assorted financials.
Jamie Clark, co-manager on the Liontrust macrothematic team, says: “Our key investment themes are populated by a selection of companies that trade on ratings which, if not consistent with value, certainly imply that other investors are missing a trick.”
Its themes including ageing populations, which it plays through life insurers (Legal & General (LGEN), Aviva (AV.), Phoenix (PHNX) and Prudential (PRU)); infrastructure spending, which it taps into through domestic housebuilders (Taylor Wimpey (TW.), Barratt Development (BDEV), Persimmon (PSN) and Telford (TEF)), building materials businesses (Marshalls (MSLH), Ibstock (IBST), Forterra (FORT)) and resource companies (Rio Tinto (RIO), Anglo Pacific (APC)); and data growth, which it accesses though UK (Vodafone (VOD), BT (BT.A)) and US (AT&T (T), Verizon (VZ)) telecom operators.
He adds these shares stand to benefit from the ‘unchecked growth’ of global data traffic and investors seeking out less expensive sources of defensive earnings.
Trusts and funds to consider
Troy Trojan Income (core growing income and growth)
TR 1 year 7.2%, 3 years 24.9%, yield 3.8%
For those who think 2018 will be a choppier year for the UK stockmarket, this fund is well worth considering. Wealth preservation is the name of the game for fund manager Francis Brooke.
Over the past decade it is the only open-ended UK equity income fund that has achieved the feat of raising its dividends year after year. “The fund has a low turnover and a focus on quality companies with a strong economic moat,” notes Alan Steel.
Threadneedle UK Extended Alpha (core growth)
TR 1 year 12.4%, 3 years 30.4%, yield 1.7%
“Threadneedle have a solid UK team and this fund leans on their collective expertise,’ remarks Rob Burdett. But, he adds, the big attraction that makes the fund more interesting at the start of 2018 is its ability to short, in other words bet against up to 30% of the portfolio in companies the manager (Chris Kinder) thinks are going to see their share prices decline. “This could offer some benefits in a falling market,” adds Burdett.
LF Woodford Equity Income (core income)
TR 1 year 1.3%, 3 years 17.9%, yield 3.5%
Since the start of 2016 performance has been pedestrian, leading some to ask whether respected fund manager Neil Woodford has ‘lost it’.
Woodford, who last summer issued an apology to investors, is adamant that the way he has positioned the fund, towards UK stocks earning most of their money in the UK rather than abroad, will pay off over the long term.
Mick Gilligan is backing Woodford to return to form. “These parts of the market [where Woodford is investing] look attractive when taking a long-term view,” says Gilligan.
Schroder Income (adventurous income and growth)
TR 1 year 10.9%, 3 yrs 24.3%, yield 3.3%
Following the value style of investing, this fund invests against the crowd, buying shares that the managers (Kevin Murphy and Nick Kirrage) believe have been unfairly mispriced by the market but will recover on a three- to five-year view.
According to the managers: “History shows that valuations are the key to future returns, and if you overpay for stock with a high dividend you will struggle to make money.”
Brain Dennehy tips the fund, pointing out it has grown dividends in eight of the last 10 years.
Fidelity Special Situations (adventurous growth)
TR 1 year 16.2%, 3 years 44.1%, yield 1.5%
Another fund tipped on the grounds of its ‘value’ style of investing. Managed by Alex Wright, the fund has more than a quarter of its money in financials, so an interest rate rise would boost performance overnight.
As John Husselbee of Liontrust points out: “Being active requires a fund to be different from the index and its peer group.”
Henderson Opportunities Trust (HOT) (adventurous growth)
SPTR 1 year 36.8%, 3 years 31.8%, discount -16.8%, yield 1.9%
HOT has pulled well ahead of the FTSE All Share index (ASX) in the decade since the highly regarded James Henderson took charge, despite a steep setback in 2008.
Henderson finds many of his most rewarding ideas among small cap and Aim companies, which currently account for nearly three-quarters of HOT’s portfolio; however, he off sets its gearing with large-company holdings and can raise their weighting if he thinks smaller companies look overvalued. Peter Hewitt says HOT offers exposure to Henderson at his best, and with a wide discount.
BlackRock Smaller Companies (BRSC) (adventurous growth)
SPTR 1 year 44.6%, 3 years 76.4%, discount -12%, yield 1.6%
BRSC has been spectacularly successful since Mike Prentis and his team took charge in 2002, with a 10-year SPTR of over 300%.
The portfolio is focused on quality businesses able to sustain their advantage, and its long list of holdings reduces stock specific risk.
Jean Matterson expects its growth and momentum bias, and its substantial exposure to companies with a high proportion of sales generated overseas, to stand it in good stead. She rates it a strong hold.
Tim Cockerill says: “Small caps have tended to provide stronger growth, long term, compared with large cap stocks. Who better to manage them than one of the UK’s most experienced teams?”
BlackRock Throgmorton Trust (THRG) (core growth)
SPTR 1 year 43%, 3 years 78.8%, discount -15.7%, yield 1.8%
THRG has been managed by Mike Prentis and his BlackRock team since July 2008. Its long portfolio is similar to that of BRSC, and its returns over the last five years have been similarly impressive.
It differs from BRSC in that up to 30% of its assets can be invested in contracts for difference (CFDs), which can capitalise on falling as well as rising prices.
John Newlands did well with THRG in 2017, and is backing it again. “The very best UK smaller companies have the potential to thrive whatever the outcome of the Brexit saga, and this is the team to identify those qualities,” he says.
Greencoat UK Wind (UKW) (income growth)
SPTR 1 year 5.9%, 3 years 27%, premium 6.2%, yield 5.5%
Charles Murphy believes that political risks make investing in UK equities unattractive. He has therefore made the only trust dedicated to UK wind farms his UK choice.
He says it is sensibly managed, lightly leveraged, offers an attractive yield and will benefit if a poorly executed Brexit leads to further sterling weakness. “Unlike many of the renewables funds, Greencoat’s dividend is covered and we believe that the board will be able to grow its dividend in line with RPI,” he comments.
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This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.